Taxpayer Was a Bona Fide Resident of U.S. Virgin Islands

The Tax Court held that a
taxpayer, who had filed tax returns with the U.S. Virgin
Islands Bureau of Internal Revenue (VIBIR) for 2002-2004,
was a bona fide resident of the U.S. Virgin Islands for
those years, and thus the statute of limitation on
assessment had expired on the U.S. returns for those years
for which the IRS had issued a notice of deficiency.

Background

Travis Sanders was a U.S.
citizen who built his own company in the United States to
manufacture and distribute surge suppression devices. In
2002, he signed an employment agreement to work for Madison
Associates, a limited partnership organized in the U.S.
Virgin Islands, a territory of the United States, as a
professional consultant. The employment agreement required
Sanders to become a resident of the U.S. Virgin Islands.
Sanders also signed an agreement making him a limited
partner of Madison. Under that agreement, he was required to
provide an opinion letter from a law or accounting firm
stating that he would qualify as a resident of the U.S.
Virgin Islands and provide any documentation required in the
future by Madison to prove his continued residence in the
territory.

For the years at issue, 2002-2004,
Sanders actually lived in the U.S. Virgin Islands. In 2002,
he stayed at a condominium in its capital, St. Thomas, and
in 2003 and 2004 lived on a yacht moored in a harbor in St.
Thomas. From 2002-2004, Sanders' checks for his bank
accounts reflected a U.S. Virgin Islands address. In
addition, he was married in June 2003 and listed St. Thomas
as his place of residence on the marriage license.

Taking the position that he was a bona fide resident of
the U.S. Virgin ­Islands, pursuant to Sec. 932(c)(2),
Sanders filed Forms 1040, U.S.
Individual Income Tax Return, with the VIBIR for
tax years 2002, 2003, and 2004. Because he was filing his
returns with the VIBIR, he did not file returns with the
IRS, in accordance with IRS Publication 570, Tax Guide
for Individuals With Income From U.S.
Possessions.

More than three years after Sanders
filed Forms 1040 with the VIBIR, the IRS mailed him a notice
of deficiency determining that he was not a bona fide
resident of the U.S. Virgin Islands for tax years 2002-2004
and treating him as a nonfiler for U.S. tax purposes. In the
notice of deficiency, the IRS also asserted, among other
things, that Sanders (1) was not a bona fide resident of the
U.S. Virgin Islands for tax years 2002-2004; (2) was not
entitled to the gross income exclusion under Sec 932(c)(4),
which allows an exclusion on the U.S. income tax return of a
bona fide U.S. Virgin Islands resident for income properly
reported on the taxpayer's U.S. Virgin Islands tax return
for tax years 2002-2004; (3) and was required to file a Form
1040 for each of the tax years 2002-2004 with the IRS (i.e.,
he was required to file a U.S. income tax return for those
years).

Sanders filed a petition in Tax Court in
response to the notice of deficiency. He contended that
filing his return with the VIBIR started the running of the
statute of limitation on his U.S. return for each year, and
thus the limitation period for assessment for the years
2002-2004 had run, and the IRS could not assess deficiencies
related to those years. After filing the petition, in
November 2012 Sanders died, but the case was continued by
his estate.

The Tax Court's
Decision

The Tax Court held that Sanders' estate had
proved that the statute of limitation on assessment for the
years 2002-2004 had expired before the IRS issued its notice
of deficiency. The court found that under the ­Sochurek
test, Sanders had been a bona fide resident of the U.S.
Virgin Islands during the years at issue, and, therefore,
under Sec. 932(c), his filing of returns for those years
with the VIBIR satisfied his U.S. filing requirement.
Therefore, the statute of limitation on a U.S. return for
Sanders for 2002-2004 began when he filed his returns with
the VIBIR.

The U.S. Virgin Islands has its own tax
system based on the same tax laws and tax rates that apply
in the United States. Sec. 932 provides rules that govern
the coordination of the U.S. income tax system and the U.S.
Virgin Islands income tax system. Sec. 932 establishes two
distinct filing regimes: one for bona fide residents of the
U.S. Virgin Islands and one for those who are not bona fide
residents. Bona fide residents file their tax returns with
the VIBIR, and, under Sec. 932(c), this return satisfies the
taxpayer's territorial and federal filing obligations. Those
who are not bona fide residents must file two income tax
returns: one with the IRS and one with the VIBIR.

Finding that Sanders had properly filed Forms 1040 with
the VIBIR for tax years 2002-2004, and that the Forms 1040
he filed were valid returns for purposes of starting the
running of the statute of limitation under Sec. 6501(a)
under the four-part test from Beard,
82 T.C. 766 (1984), aff'd, 793 F.2d 139 (6th Cir. 1986), the
only question left was whether Sanders was a bona fide
resident of the U.S. Virgin Islands who could take advantage
of the rule in Sec. 932(c). To make this determination, the
court applied the 11 factors set out in Sochurek,
300 F.2d 34 (7th Cir. 1962).

The 11 factors are (1)
intention of the taxpayer; (2) establishment of a home in
the foreign country for an indefinite period; (3)
participation in activities; (4) physical presence in the
foreign country; (5) nature, extent, and reasons for
absences from his temporary foreign home; (6) assumption of
economic burdens and payment of taxes to the foreign
country; (7) status of the resident contrasted to transient
or sojourner; (8) treatment accorded his income tax status
by his employer; (9) marital status and residence of his
family; (10) nature and duration of employment; and (11)
good faith in making the trip abroad. The 11 factors can be
further grouped into four broad categories: intent; physical
presence; social, family, and professional relationships;
and the taxpayer's own representations (Vento v.
Director of V.I. Bureau of Internal Rev., 715 F.3d 455 (3d Cir. 2013)).

After considering the facts and circumstances and
applying the Sochurek
factors as grouped in Vento,
the court found that Sanders was a bona fide U.S. Virgin
Islands resident from 2002-2004. The court came to this
conclusion because he had the intent to be a bona fide
resident because he intended to remain indefinitely or at
least for a substantial period; he had a physical presence
in the U.S. Virgin Islands and was employed by a U.S. Virgin
Islands partnership and was listed as a partner on its
Schedules K-1 for tax years 2002-2004; he conducted banking
in the U.S. Virgin Islands and had checks with a U.S. Virgin
Islands address; he was married in the U.S. Virgin Islands
and reported his address as the U.S. Virgin Islands on his
marriage license; and, finally, he identified himself as a
resident of the U.S. Virgin Islands and paid U.S. Virgin
Islands taxes.

Reflections

The
reason the IRS was so interested in proving that Sanders was
not a bona fide U.S. Virgin Islands resident was that, as
such, Sanders had taken under the Virgin Islands Economic
Development Program (EDP), a credit of 90% of his U.S.
Virgin Islands tax liability attributable to his portion of
the net income derived by Madison. As the IRS described in
Notice 2004-45, taxpayers who are not bona fide residents of
the U.S. Virgin ­Islands have become partners in
partnerships similar to Madison and have fraudulently
claimed that they are bona fide residents to avoid tax
through an EDP credit. However, regardless of whether it is
good policy to give someone this credit when he or she
simply runs a U.S. business through a U.S. Virgin Islands
partnership, under the law as it stands, if the person does
so, lives in the U.S. Virgin Islands, and qualifies as a
bona fide resident of the territory, he or she can file a
U.S. Virgin Islands return and take the credit.

In
Chief Counsel Advice 201503012, released Jan. 16, 2015, in
response to the Vento
decision, the Office of Chief Counsel advised that the
11-factor test from Sochurek
is still the proper standard for analyzing whether a person
is a bona fide resident of the U.S. Virgin Islands in cases
involving facts that are substantially similar to those in
Notice 2004-45 and that the Vento
decision did not alter this standard. In Vento,
the Third Circuit held, based on the facts, that a husband
and wife were bona fide residents of the territory while
their three daughters were not.

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